Estimation of Cost of Capital 101Industry lev. Cost of equity Cost of debt Debt/capital Cost of capital
Industry Beta (percent) (percent) (percent) (percent)
Aerospace 0.68 8.6 9.1 38.6 7.3
Airlines 0.89 10.8 9.8 70.4 7.4
Beverages 0.89 10 8.1 45.7 9.3
Cars and trucks 1.03 12.4 8.5 46.6 8.7
Computers and 1.36 12.9 8.6 30.7 12.7
peripherals
Electronics 1.51 14.1 10.6 39.1 13.5
Oil and gas 0.60 7.9 8.6 46.7 6.9
(integrated)
Restaurants 0.80 9.5 10 46.4 8.6
Source: Stern Stewart & Co.
Exhibit 4.9 Industry betas
Industry Beta
Steel 1.17
Banking 1.84
Power 1.17
Cement 1.04
Pharmaceuticals 1.02
Automobiles 0.99
Textiles 0.84
Tyres 0.92
Paints 0.50
Cosmetics 0.80Fundamental Beta
Since firm characteristics change over a period of time we would expect beta to change. So putting too much
emphasis on history might be unwise. Consequently some academicians like Beaver et al. (1970) and
Rosenberg and Marathe (1975) have attempted to establish relationship between systematic risk and its
determinants like payout ratio, growth, leverage, liquidity ratio, size of the firm, EPS variability. Studies
have shown that the beta obtained from such ‘fundamental factors’ is more stable. About 54 factors in six
categories are supposed to influence beta. A growth-oriented strategy implies large capital investment plans.
Such long-term investments typically translate into higher uncertainty about the eventual outcome and hence
risk. So we would expect growth to be a consistent predictor of beta. Likewise earnings variability is another
important predictor of beta. An important research by Robert Hamada shows that the beta of a stock depends
on operating and financial leverage of a firm. An increase in either of them or both will lead to an increase in
beta, and hence the cost of equity.
The relationship between levered and unlevered beta is:^4βL = βU [1 + (1 – T)D/E](^4) The effect of leverage on beta is not too clear in the Indian context. But it is better to be vaguely right than precisely
wrong!